u*=4.5% u=6.5% u cyclical =2% y= $19.2 trillion y*= $20 trillion

1. When you calculate the price of a $10,000 face value bond with three years remaining until maturity with an interest rate set equal to your value of i=u and coupon rate equal to c= u* you get $9470.325. Assume the Fed responds to the information above by changing interest rate by 1% over the course of the following year. Assume the Fed changes rates in the expected direction based on what you observed in the cyclical rate. Calculate the new price and rate of return of the same bond with two years remaining. Why did the Fed take this action?